As we wrap up what looks like will be the second consecutive year of decline for cannabis stocks, I find it interesting to observe that 5 of the 27 stocks on my Focus List at 420 Investor have produced double-digit gains despite tremendous headwinds. Regular readers should be familiar with 4 of them, as I have written about them over the past two years in this column.
Make no mistake, there have indeed been tremendous headwinds. The market has dropped 32.1% so far in 2019, following a 54.9% decline in 2018, with the current price of the Global Cannabis Stock Index testing levels not seen in more than 3 years:
NCV Global Cannabis Stock Index 5 year 11-22-19
While I am not much of a momentum chaser when it comes to investing, I have been around long enough to understand that when a stock can withstand a bear market, the company is probably doing something right, and that when the market turns, as I believe it is in the process of doing, the stocks can deliver big gains ahead. Further, I note that each of the 5 stocks that have prospered despite a weak overall market are down substantially from their 52-week highs.
With that in mind, I will now review each of the 5 American cannabis stocks on my Focus List that have delivered gains in excess of 20% thus far in 2019. Please keep in mind that I am not recommending purchase of any of these companies as I discuss them in alphabetical order.
Green Thumb Industries
Chicago-based Green Thumb Industries, a multi-state operator with licenses in a dozen states, has rallied 20.5% in 2019 thus far, though it is down over 40% from its 52-week high. I wrote about it after it debuted in the summer of 2018, contrasting its strong investor reception in contrast to MedMen’s. Since that article was published, MedMen, which I described as “overpriced”, has declined 84.3%, while GTI has gained 21.3%.
In its most recent quarter ending in September, GTI experienced revenue growth of 296% from a year ago and 52% from the prior quarter as it generated sales of $68 million and produced an adjusted operating loss of less than $2 million. It reported a positive adjusted EBITDA for the second consecutive quarter and demonstrated stable and high gross margins and an ability to scale its infrastructure as its operating expenses grew more slowly than its revenue.
I believe that investors are gravitating to the stock, which has rallied 14.7% in November, due to not only the strong top-line and bottom-line growth but also its relatively strong balance sheet that will allow it to grow even if capital access for the sector remains constrained. The company has a very strong position in the rapidly growing Pennsylvania medical cannabis market as well as the Illinois medical cannabis market that will be legal for all adults in January and has a market capitalization of C$2.2 billion
While hydroponics store operator GrowGeneration has dropped 25.1% from its 52-week high, which occurred a couple of weeks after I wrote about the company in this column in late August, it is still up 89% year-to-date. The company’s Q3 earnings report continued a trend of very strong financial performance, with revenue gaining 159% from a year ago and rising 12% from the prior quarter to $21.8 million as the company reported operating profits of $1.1 million.
As I described in August, GrowGeneration, which further raised its financial outlook, is experiencing strong organic growth that accelerated to 48% along with a strong contribution from its acquisitions and new store openings, particularly in Oklahoma. I continue to expect the stock to perform well over time, but I am concerned that the strength in the Oklahoma market could slow as it becomes saturated with operators. Further, and more importantly, should capital access remain constrained for its customers, the company may experience a slowing of growth. At the same time, though, the stock appears to be relatively inexpensive, with a market cap of $181 million. The company has guided to 2019 adjusted EPS of .14-.18, which means it is trading at 26.6X current earnings at the mid-point, well below its growth rate.
Innovative Industrial Properties
NYSE-listed REIT Innovative Industrial Properties has been wildly successful after a rough debut in late 2016. The stock, which did its IPO at $20 per share and spent almost the entire next year below that price, hit an all-time high earlier this year of $139.53. While it has declined 43.4% since then, it is still up 71.7% this year.
As capital has dried up for the industry, several multi-state operators have commenced or expanded relationships with the company, which has successfully raised $634 million to date, including both GTI and Trulieve, building a portfolio that has a yield it reports at 13.6%.
I first shared my perspective in this column in February 2018, identifying its emergence from its post-IPO slump and detailing its progress. It has far exceeded my expectations as the risks I detailed at the time haven’t impacted the company. At this time, the stock seems a bit expensive to me, especially in light of the current capital access issue. Already one of the company’s tenants has been put in receivership, though I don’t expect the company to absorb any sort of substantial loss, if any at all. The incident, though, should wake up investors to the potential for asset failures in its portfolio. I believe that the company would find it difficult to find operators of some of its facilities were it necessary to do so and could suffer some write-downs. Further, a lot of competition has cropped up. Innovative Industrial Properties has been taking on higher quality tenants at lower rates of return lately as well.
While a weak cannabis market could hurt its returns should a tenant run into trouble financially, there is a completely different risk that investors should understand. At present, the company, which sports a market cap of $1.14 billion and a dividend yield of 4%, is valued as a growth REIT. Should the SAFE Banking Act pass, it is quite possible that traditional banks could provide mortgage lending to cannabis companies. This would result in a revaluation of the company from a growth REIT to a high-yield, slow growth company potentially. The existing portfolio would be worth more, but IIPR would likely struggle to generate growth in its portfolio.
Finally, note that the company has an “At-the-Money” shelf registration and has been actively selling stock despite the large decline.
While I have pointed to many potential risks, the company’s execution has been stellar, and it’s very possible that it could continue to grow successfully as well, as the credit quality holds up and as competitive forces remain constrained. At its current price, investors are paying only an 80% premium to its tangible book value.
Medicine Man Technologies
Colorado-based Medicine Man Technologies, which is the one stock I have not mentioned to date in this column, is up 117.5% in 2019, the most of all five stocks I am discussing, though it has declined 31.1% from its 52-week high.
The company went public in late 2016 and was formed by Andy Williams, one of the “Pot Barons of Colorado” profiled in 2014 by MSNBC, and the late Brett Roper with the intent of leveraging and expanding the intellectual property of Medicine Man through consulting. It later added a line of nutrients and bought a hydroponics store in order to help its clients gain access to products at attractive prices. The company always had the intent to become a cannabis company by bringing in the operations of Medicine Man when legally possible, which became the case this year when Colorado finally permitted public company ownership of its licensed cannabis operators.
Williams has assembled a massive potential roll-up of some of the best operators in the state. He has also found investment support from an institutional investor and has beefed up his management team. The deals are supposed to close in 2020, but they require the company to not only issue stock but to also make large cash payments. Between now and then, the company will need to raise substantial capital at a time when doing so has become more challenging. If successful, the company will have the potential to generate substantial revenues and profits, so this is a story to watch closely as it plays out in my view.
Down the least from its 52-week high at -22.9%, Trulieve has shined again in 2019 after a good debut in 2018, rising 47.9% year-to-date and 59.2% since its debut. Readers of this column should be familiar with the Florida medical cannabis powerhouse, which has commanding market share in the state, as I have written about it twice, including last December, when I detailed its strong revenue and profitability, and, more recently, in June, when I detailed its expansion efforts in California.
The company has maintained its leadership among all of the multi-state cannabis operators in terms of revenue, which was $70.7 million in Q3, up 22% from Q2 and 150% from the same quarter in 2018. It stands out for its profitability, reporting an adjusted operating income of $23.4 million (33% of sales).
It’s easy to be a fan of the company and its CEO, Kim Rivers, who is kicking butt in an industry (okay, country) dominated by male CEOs, with its patient-focused approach and its financial discipline. The stock trades at a much lower multiple to current sales than peers, with a market cap of C$1.3 billion, which is less than 4 times the US$250 million in sales it will likely generate.
Many investors question the potential to maintain margins in Florida as the market becomes more competitive and aren’t impressed with its efforts to expand beyond the state. They have purchased what Rivers calls a test dispensary in Palm Springs, California as they prepare to expand over time, recently acquired a medical cannabis company in Connecticut and have a early-stage project in Massachusetts, where they hope to bring on cannabis production in 2020 to a state that is seeing a big shortage.
Capital access constraints could allow the company to maintain its massive lead in Florida for quite some time. I would argue that while other opportunities may not be as great for the company as in its home state, they could be great opportunities nonetheless. One question that needs to be addressed is how the company will compete in adult-use markets, where it has not yet been tested.
In conclusion, these five companies, which include two leading MSOs, a pending Colorado-focused operator, a hydroponics store operator and a cannabis-focused REIT, have bucked the trend of a declining cannabis sector thus far in 2019, though they have all retreated more than 22% from their 52-week highs.
Disclaimer: I mentioned Medicine Man Technologies, which is a client of mine at New Cannabis Ventures, where we provide an investor dashboard on its behalf. We disclose all public company clients here. I do not own any stocks mentioned in this article, though I may include them in one or more model portfolios at 420 Investor.